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Statement by
Robert C. Holland, Member
Board of Governors of the Federal Reserve System
before the
Subcommittee on Financial Institutions Supervision,
Regulation and Insurance
of the
Committee on Banking, Currency and Housing
House of Representatives

December 17, 1975


I am pleased to appear before this Committee
on behalf of the Board of Governors of the Federal
Reserve System to discuss Title IV of the FINE
Discussion Principles” relating to the regulatory
We at the Board are impressed, Mr. Chairman,
with the thoughtful approach which your Committee
is employing in its study of Financial Institutions
in the Nation's Economy.

Your study wisely recognizes

the interrelation of efforts to restructure financial
institutions with questions relating to housing,
holding company operations, international banking
activities, and the role of the regulatory agencies.
The Board hopes that it will be able to contribute
to your comprehensive efforts in a meaningful way.
Turning to the Discussion Principles relating
to the regulatory agencies, I note that Title IV
starts with a reference to Chairman Burns' speech
before the American Bankers Association in October 1974.


- 2 -

You will recall that I also used that speech as a
starting point in my testimony before this Committee
last July.

As I indicated at that time, the Federal

Reserve, for more than a year, has been making
detailed studies of the problems highlighted in
that speech and what might be done to help correct

As a part of those efforts, we have given

careful thought to the structure of Federal bank
supervision and regulation.
In my testimony last July, I offered certain
tentative conclusions reached by the Board.


that time our studies have continued, our views
have been evolving, and

they are continuing to

In the course of these deliberations our

positions on two of the tentative conclusions offered
last July have solidified.
Our first and foremost conclusion is that
the Federal Reserve, as the nation's central bank,
needs to be closely involved in the process of bank
regulation and supervision.

Our second conclusion


- 3 is that some improvement in the present structure of
the Federal bank regulatory agencies is desirable.
Let me explain how we have reached each of these
conclusions, and relate our thinking to the distinctive
features of the proposals put forth in the FINE
Discision Principles.
The place to begin, as we see it, is with
the relationship between monetary policy and
regulatory policy.

Now, more than ever, the Federal

Reserve's role as monetary policymaker and as lender
of last resort interacts with the effects of prevailing
bank supervisory and regulatory policies.

Each of

these areas of public policy increasingly influences
the effectiveness of the other.

To divorce them is

to weaken both.
Because of the importance we attach to this
particular issue, let me give you some concrete
examples of our concern.

Fundamentally, monetary

policy works by affecting the liquidity position of
banks and the financial system.

Good bank supervision


- 4 should, and will, examine the liquidity of individual
banks and urge the correction of inappropriately thin
or exposed liquidity positions.

But if bank super­

visory policy is set without full understanding of
broad economic developments or the trend of monetary
policy, the supervisor can be impelling ill-timed
banking actions.

The enforced write-downs of bank

assets to the unrealistically depressed market
values reached during the Great Depression were
among the most unfortunate examples of such toor
narrow supervisory vision.
On the other hand, if the bank supervisor
sets too-low liquidity standards, or none at all,
or changes them at an inopportune moment, he can
dilute or frustrate for a time the thrust of monetary

For example, the bulge of the past few years

in loan commitments -- that is, in bank promises to
lend money upon request, made chiefly to businesses -both slowed and skewed the restraining effects of
monetary policy, and thereby helped worsen our inflation.


- 5 Those adverse effects could have been considerably
worse, were it not for the fact that the Federal
Reserve, drawing upon its supervisory as well as
monetary responsibilities, took the initiative in
expressing concern to bankers regarding the large
build-ups in their commitments.

With the benefit

of hindsight, however, I wish that our counter­
measures could have been even more v i g o r o u s .
Bank capital standards set by supervisors
also interact with both national economic and
monetary policy.

Supervisory rules that require

banks to raise their capital ratios or that make
it more difficult for banks to raise capital can
reduce the availability of bank funds to prospective
borrowers and thus slow the rate of growth of bank
credit and money.
to monetary policy.

These are matters of significance
For example, right now, in the

wake of several years of strong bank credit expansion
and some recent loan reverses, a strengthening of
capital positions of many banks is most desirable.


- 6 -

But supervisory pressure for improving capital
ratios should not be overdone in this environment,
as it could deter bank willingness to lend to the
extent of interfering with the financing of recovery.
Nor, for the same reason, should supervisory pressure
be such as to inhibit the ability and willingness
of banks to go to the market to raise needed capital.
There are two other important aspects of
interaction between supervisory and monetary
considerations that should be accented.
Bank supervisory activities provide a flow
of information concerning detailed developments
inside the banking system that can be of inestimable
value to monetary policymakers.

Examiner asset

evaluations supply first-hand knowledge of the
changing quality of credit, and of the quality of
bank management that is administering that credit.
Important insights are gained also into bank policies
regarding liability management and participation in
various types of credit markets.

This kind of


information provides valuable supplements to the
meaning of the quantitative statistics on monetary
and credit aggregates.
When one turns to the regulation and
supervision of international banking activities,
more monetary implications ensue.

Changes in

bank rules or examiner standards can generate
flows of funds into or out of this country that
markedly alter the international balance of payments
and the foreign exchange value of the dollar.
Similarly, such changes can create financial
problems for other countries and adversely affect
the relations between our country and o t hers.
In all these supervisory and regulatory
matters, the standards of objective examiner
professionalism need to be respected, but such
standards need to take account of Sheir broader
domestic and international consequences.

To our

mind, this reasoning argues decisively for a close
relation between monetary policy and supervisory
and regulatory considerations.


- 8 -

The Board's deliberations have led to the
conclusion that an optimum system of bank regulation
and supervision is one that would achieve three main

(1) to keep banks safe and sound,

(2) to protect the legitimate interest of present
and would-be bank customers, and (3) to be attentive
to overall monetary considerations.
It might seem logical to pursue these various
objectives by consolidating all the public agencies
concerned with them under one roof.

That would

amount to centralizing all banking and monetary
powers in one agency.
However, experience with regulation in
industries other than banking suggests that placing
all regulatory authority in a single agency does not
necessarily result in sound regulatory policy.


much centralization entails substantial risks.
To the extent that the possibilities of criticism
and constructive differences of view from within the
regulatory structure are eliminated, the benefits


- 9 -

of knowledgeable checks and balances are diminished.
The stimuli to initiative and innovation are reduced.
A sole bank supervisory agency, not subject to
challenge from sister agencies, could tend to become
inflexible, or even ossified.
In addition, any supervisory agency design
needs to take careful account of the danger of the
development of an unhealthy relation between the
supervised and the supervisors.

I believe Federal

government agencies generally make a sincere effort
to avoid either dominating or becoming captives of
the industries they regulate.

However, the necessary

closeness of the relationship creates opportunities
for undue influence which must be guarded against.
As we have weighed these risks against the
improvements upon recent performance that could
realistically be expected to flow from complete
centralization of Federal bank regulatory authority,
we have concluded that the gains are not worth the
risks, at least at the present stage of experience.


- 10 -

For similar reasons, we have concluded that there
are not such critical shortcomings in our present
regulatory system as to call for the kind of drastic
overhaul proposed in the FINE Discussion Principles.
Certain special features of the FINE proposal,
however, call for some added comment.
First, the regulatory commission proposed
in the Discussion Principles would include as a
member of the five-man commission the Vice Chairman
of the Federal Reserve Board.

We are pleased with this

recognition of the need for the Board's representation
on a commission regulating depository institutions.
However, for the reasons I set forth in the first part
of my statement, the Board believes that the relation
between monetary policy and bank supervision and
regulation should be strengthened rather than weakened
as it would be under the FINE proposal.
Second, the FINE proposal would include under
the jurisdiction of the new Federal Depository
Institutions Commission not just commercial banks


- 11 -

but also all Federally insured savings and loan
associations, mutual savings banks and credit unions.
We agree that there is some logic in this proposal.
As the activities of other depository institutions
are permitted to take on more of the attributes of
banking, the distinctions between the different
types of institutions become increasingly blurred,
and the need to coordinate their regulation and
supervision grows correspondingly stronger.


this time, however, the Board believes that, logical
as it may appear, combining the regulation of all
depository institutions in one supervisory authority
at one stroke would be too potentially disruptive a
step to take.
Third, your Discussion Principles implicitly
recognize that there is a problem in consolidating
five Federal supervisory authorities into one by
suggesting a three-year transition period.


Board agrees that any change of the character
proposed would have to be made gradually.


- 12 -

In our view, however, it is preferable tc start with
less sweeping substantive changes in the structure
of depository regulation, and then to introduce
further reforms as necessary, building on the
experience gained from the actions previously taken.
I shall be making more explicit comments in this
vein later on in my statement.
We are led to recommend this more moderate,
step-at-a-time approach by our analyses of the
banking problems that have surfaced in recent years.
Our studies indicate that many of such banking
problems would probably have occurred regardless
of what structure of Federal supervisory agencies
was in place, and that most of them can be dealt
with without a drastic restructuring of the banking
In the light of recent experience, many
necessary or desirable corrective measures have
already been introduced by both banks and bank

- 13 supervisors.

Banks in general have been sobered

by the problems they have faced and are taking a
more prudent posture both in pursuing new activities
and in monitoring possible excesses.

The agencies,

on their part, have launched a number of important
remedial measures to improve bank examination,
supervision, and regulation.

Some of those measures

I mentioned in my testimony here last summer.
Without taking the time to repeat and expand upon
them, I will simply attach as an appendix to this
testimony a list of some of the significant changes
and proposals that the Federal Reserve itself has
Surveying all these and similar changes,
we believe they promise a substantial and responsible
improvement in the banking environment.

But I am not

here to try to lull this Committee into inaction with
a claim that "Everything is fine.” On the contrary,
we believe there are certain problem areas where
current progress is not good enough, or fast enough,

- 14 or uniform enough to be satisfactory.


the Board has concluded that some change in the
Federal bank supervisory structure, designed to
improve performance in those particular areas,
would be worthwhile.

To be specific, the objectives

that we have in mind are:

(1) to more efficiently

and uniformly modernize bank examination and
surveillance procedures, (2)

to provide for more

vigorous and consistent follow-up procedures when
bank examinations reveal weaknesses, (3) to attain
greater consistency in some regulations, and
(4) to improve the coordination of bank supervision
with monetary policy.
What agency changes would do most to foster
these objectives while avoiding the pitfalls cited
earlier in this testimony?

The answer to that

question is, in the end, a matter of personal

On balance, no one proposal for agency

reform has gained the support of a strong majority
of the Board at this time.

Two different reform

proposals, however, have developed strong support
within the Board.

- 15 The first, and perhaps the simplest, is to
consolidate the functions of the Office of the
Comptroller of the Currency within the Federal
Reserve System.

This? change would eliminate some

of the anomalies pointed out in the Discussion

Indeed, it could accomplish a good

deal of what is claimed would be accomplished by
a complete consolidation of Federal bank supervisory
functions, without some of the dangers of complete
There is logic in this proposal, because all
national banks are required to be members of the
Federal Reserve System and thus subject to its
regulations, but their primary examination and
supervision lies with the Comptroller; the Board
has supervisory responsibility for all bank holding
companies, and yet many of the major bank subsidiaries
of such holding companies are national banks; the
Board must approve the opening of foreign branches
of national banks consistent with its international


- 16 monetary responsibilities, but the supervision
and regulation of those branches rests with the
Comptroller; the Board authorizes Edge Act
corporations, but many of the banks with whom
those corporations are associated are supervised
by the Comptroller.
The examination and supervision of national
and State member banks could be integrated efficiently.
At the same time, the continued existence of the FDIC
would provide another Federal banking agency to check
or stimulate the supervisory and regulatory actions
of the Federal Reserve.
If the Congress should make such a change in
bank regulatory structure, it would then seem
appropriate to have the incumbent of the Office
of the Comptroller of the Currency added as an
eighth member of the Federal Reserve Board until
the next Board vacancy occurred, at which time he
would be appointed to fill that vacancy.

- 17 The second reform proposal which has
developed strong support within the Board is one
I outlined to you in July, namely, the creation
of a Federal Bank Examination Council.

Such a

Council would be focused on the areas that we
believe are most in need of improvement -- i.e.,
efficient and uniform modernization of bank
examination and vigorous and consistent follow-up
procedures when bank weaknesses are revealed.
Such a Council could be established administratively
or by statute.

Its statutory authorization would

undoubtedly give more impetus to the establishment
of such a Council, and would also provide it with
more clear-cut authority to take definitive action
within its statutorily defined areas of administration.
The Federal Bank Examination Council should
have authority to establish standards and procedures
for bank surveillance, examination and follow-up,
applicable to all the Federal banking agencies, and
it should review significant problem cases when and
as they develop.

All three Federal banking agencies

- 18 should be represented on the Council.


of the importance of close coordination between
bank supervision and monetary policy, we would
favor appointing a member of the Board as our
Council representative and making him Chairman
of the Council.
Establishment of a Federal Bank Examination
Council of this kind would be consistent with an
experimental and evolutionary course of action.
Experience with the Council would conceivably lead
in time to the conclusion that some further
consolidation of banking regulatory and related
authorities would be desirable.

If so, that

decision would be based upon actual experience
and a greater practical awareness of the difficulties
to be overcome than we now have.

This step-by-step

approach to reform in bank regulatory structure
could, we believe, bring about significant improve­
ments in bank supervision without risking the
potential disruption that could accompany more
sweeping changes.

- 19 -

The adoption of either of the two reform
proposals that I have sketched should help to reduce
instances of "competition in laxity" such as were
noted by Chairman Burns in his October 1974 address.
They would, at the same time, continue a system of
checks and balances which, as Chairman Burns also
observed, "is the traditional way of guarding
against arbitrary or capricious exercise of authority."
The Board recognizes that reasonable men
differ on the scope and desirability of revisions,
if any, in the regulatory structure.

As I have tried

to indicate, we are not wedded to the status q u o .
We look forward to continued work with your Committee
in developing the most practicable and desirable
revisions in the regulation and supervision of
depository institutions.





Recent Activities by the Federal Reserve in
the Area of Banking Supervision and Regulation,
Including Legislative Proposals and Regulatory
and Administrative Actions

Legislative Proposals

Bill to: (a) strengthen penalties for
violation of cease and desist orders;
(b) place aggregate limits on loans to
insiders and their interests; (c) permit
easier removal of officers or directors
of a banking institution; and (d) permit
divestiture of a bank holding company
subsidiary (S. 2304).


Bill to permit more expeditious handling of
problem bank and bank holding company
situations and to permit acquisition of
a problem bank by an out-of-State bank
holding company (H.R. 4008).



Bill relating to the supervision of foreign
banks in the United States (S. 958, H.R. 5617).

Bill extending application of reserve
requirements to all depository institu­
tions (S. 2050, S. 1961).

Regulatory Actions

Changes in Regulation A relating to member
banks' access to longer-term emergency


Amendments to Regulations H and F requiring
State member banks to treat standby letters
of credit and ineligible acceptances in the
same manner as loans.






Proposed guidelines for evaluation of
requests, and regulatory changes to
increase flexibility in the issuance
of notes and debentures by State
member ba n k s . (Comments under review)

C . Administrative Actions

Increased efforts to examiners to identify
potential problem State member banks.


Increased efforts to identify potential
liquidity problems of all banks.


Intensified and more uniform follow-up
procedures when a problem bank is identified,
including progress reports, meetings with
directors, and special-purpose examinations.


Uniform procedures relating to identification
of bank holding company liquidity problems
and on-site examinations.


Introduction of interagency early warning
system regarding subsidiaries of bank
holding companies.


Initiation of an expanded computerized
surveillance system for bank holding


Expanded efforts to identify risks associated
with banks’foreign exchange trading and to
improve ba n k s ' audit and control procedures.


Clarification of limitations on bank
extensions of credit to their holding
company affiliates.
(Being transmitted
to banks)